UNIT II
UNIT III
UNIT IV
UNIT V
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UNIT-I
APPLIED ECONOMICS
Definition of Economics
The term Economics was originally derived from the two Greek word Oikos which means household
and Nemein which means management. Thus, it refers to managing of a household using the limited
funds.
1.
2.
3.
4.
5.
1.
2.
3.
4.
5.
1.
2.
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Wealth Definition
Welfare Definition
Scarcity Definition
Growth Definition
Economics
is
the
science that studies
production
and
consumption of wealth
Economics
studies
those
economic
activities of a social
man
which
are
concerned
with
attainment and use of
material requisites of
well-being
Economics is a Science
that suggests the ways
and means of how the
scarce means to be
used to accelerate the
rate
of
economic
development and to
attain higher living
standard.
Growth Definition
According to Prof. Samuelson, Economics is the study of how man and society choose, with or without
the use of money, to employ scarce productive resources, which could have alternative uses, to produce
various commodities over time and distribute them for consumption now and in the future among
various people and groups of society.
The main features of this definition are as follows
1. Samuelson has emphasized the need of choice which arises due to unlimited wants and scarcity
of resources.
2. Growth definition not only lays stress on the allocation of resources but also on their proper
utilization n so that more wants could be satisfied.
3. According to Samuelson, available resources should not only be used properly, but efforts
should also be made to increase them as to satisfy ever increasing wants.
4. Economics is not only concerned with the identification of economic problems but it should also
suggest ways and means to solve them.
5. It is a growth oriented definition which says that economics is concerned with determining the
pattern of employment of scarce resources to produce goods over tome. Thus, growth definition
studies the problem of an economy not at a point of time but over a period of time. Thus,
economics is not only concerned with the present pattern of consumption but also with future
consumption.
In short, Samuelsons definition of economics is the most comprehensive of all earlier definitions. It
includes all the issues which were highlighted in the earlier definitions on the one hand, and the issues
of economic development on the other.
Nature of Economics
Let us discuss the views of both and see exactly that economics is.
Nature of Economics
Science
Pure or Applied
Art
Positive
Normative
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Economics as a Science
1) In simple words, a science is commonly defined as a systematic body of knowledge about a
particular branch of the universe. This implies that a science is a study of a branch of learning
and not of the whole universe.
2) In the opinion of Poincare who says A science is built upon facts as a house is built of stones.
3) Applying this is to our subject, we find economics is built upon facts, examined and
systematized by economists. Further, economics like other science deduce conclusion or
generalizations after observing, collecting and examining facts. Thus, it deals with (i)
observation of facts. (ii) Measurement (iii) Explanation (iv) Verification. In short, it formulates
economic laws about human behaviour. In this way economics has developed into a science of
making and possessing laws for itself.
4) Science economics satisfies all the tests of a science, economics is regarded as a full-fledged,
science. In short, it is no way less than other sciences.
Marshall has rightly observed that
Economics is therefore a science pure and applied rather than a Science and an Art.
The economics as a science can be divided into two parts i.e. (a) Positive Science and (b) Normative
Science.
I.
Economics as a Positive Science A positive science establishes a relation between cause and
effect. It tells us that if we do a certain thing, same result will follow
In the words of Prof. J.M. Keynes
A positive science may be defined as a body of systematized knowledge concerning what is a
normative science or regulative science relating to the criteria of what it ought to be.
II.
Economics as A Normative Science Marshall, Pigou and historical school puts the arguments
that economics is normative science.
According to Marshall
Economics is a normative science because it has a norm viz; welfare.
In the opinion of Keynes,
A normative science or regulative science is a body of systematized knowledge concerning with the
criterion of what ought to be and concerned with the deal distinguished from the factual.
Therefore, a normative science describes what should be done and what should not be done.
From the above noted discussion, we can say that economics is both positive and normative science as
at present, it deals with what is and what ought to be. Therefore, it not only focuses why certain
things happen, it also conveys whether it is the right thing to happen.
Economics as an art
Art is completely different from science.
1) In the words of Cossa A science teaches us to know; an art teaches up to do. In other words,
science explains and expounds; art directs, art imposes precepts or proposes rules.In other
words, science is theoretical but an art is political.
2) What is an Art? As J.M. Keynes has put it: An art is a system of rules for the attainment of a
given end.The object of an art is the formulation of precepts applicable to policy. This implies
that art is practical. Applying this definition of art, we can say it is an art. Its several branches
like I consumption, production and public finance provide practical guidance to solve economic
problems. Again for example the theory of consumption guides the consumer to obtain
maximum satisfaction with his given income (means). In this sense, economics can be
considered as an art in the wider sense of the term art i.e. in the sense of practical science. It
means creation or practical application of knowledge. It is for this reason; we treat economics
as an art.
In a nutshell, we can conclude the discussion that economics is both science and art.
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2) Accordingly to K.E. Boulding Macro economics deals not with individuals quantities as such
but with aggregate income but with national income, not with individuals price but with price
levels, not with individuals output but with national output.
3) According to Edward Shapiro Macro economics attempts to answer the truly big question
of economic life full employment or unemployment, capacity or under capacity production.
Importance or Usefulness of Macro Economics
The following factors highlight the importance of macro economics
1. Functioning of an Economy
2. Behavior of Individual Units.
3. Indispensable for Accurate Knowledge
4. Economic Planning
5. Stud of National Income
6. Change in General Price Level
Microeconomics v/s Macroeconomics
S.No.
1
2
Points
Study
Assumption
Microeconomics
It studies individual unit
Macroeconomics
It studies aggregate or group of individual
units.
At macro level, full employment is not
assumed.
Instead
equilibrium
employment is assumed which is a real
assumption.
We study national income, theory of
wage, interest & employment. Theory of
money, theory of international trade etc.
It is useful in analysis of aggregate units
such as aggregate demand, aggregate
prices or inflation-deflation, aggregate or
national income etc.
It is more useful to Govt. in formulating
economic policies.
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economics. The determination of the rate of profit and the rate of interest are well known micro
economics topics, but they greatly depend upon the macro economics aggregates.
5) It follows that through micro economics and macro economics deal with different subjects, there is
great interdependence between them. In the explanation of many economic phenomena, both micro
and macroeconomic tools and concepts have to be applied.
MEANING OF DEMAND
Demand constitute three things as (i) desire for a commodity (ii) willingness to buy The demand for
anything at a given price is the amount of it which will be bought per unit of time at the that price.
According to Hansen, By demand, we mean the quantity of a commodity that will be purchased at a
particular price and not merely the desire of a thing.
CLASSIFICATION OF DEMAND
The main classification types of demand are as under:
1. Price Demand: Price demand refers to the various quantities of commodity which the
consumer will buy per unit of time at a certain prices (other things remaining the same). The
quantity demanded changes with the change in price. The quantity demanded increases with a
fall in price and the quantity demanded falls with an increase in price. In other words, we can
say that quantity demanded and price have a negative correlation as
DA= f (PA)
Where DA
= Demand for commodity A
f
= Function
PA
= Price of the commodity A.
P
D
P
D
2. Income Demand: Being ceterus-paribus, the income demand indicates the relationship
between income and demand of the consumer. The income demand shows how much quantity a
consumer will buy at different levels of his income. Generally, there is positive relationship
between income and demand of the consumer i.e.
DA = f (YA)
Where DA
= Demand for commodity A
YA
= Income of the consumer A.
P
D
P
D
The above function shows as the income of the consumer increases demand also increases and
when income falls demand also decreases.
3. Cross Demand: Cross demand refers to the relationship between quantity demanded of good
A and price to related good B other things being equal. In simple words, from cross demand
we mean the change in the quantity demanded of a commodity without any change in its price
but due to the change in the price of related goods i.e. B commodity. The related goods can
either be substitute goods or complementary goods. The demand curve in the case of substitute
goods or complementary goods. The demand curve in the case of substitute will be of upward
sloping while the demand curve in complementary goods will be of downward slope.
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1)
2)
3)
4)
5)
6)
7)
8)
DETERMINANTS OF DEMAND
Price of the commodity
Price of substitutes and complementary goods.
Consumers income.
Consumers taste and preference.
Consumers expectations of future prices
Demonstration effect.
Consumer-credit facility
Population of the country Distribution of national income
DEMAND SCHEDULE
Demand schedule refers to the response of amount demanded to change in price of a commodity. It
summarizes the information on prices and quantity demanded. It is of two types.
1. Individual Demand Schedule
2. Market Demand Schedule
1. Individual Demand Schedule: Considering other things being equal individual demand schedule
refers to the quantities of the commodities demanded by the consumer at various prices. It can be
with the help of table 1:
Individual Demand Schedule
Price per unit of the bale
Quantity Demanded
5
1
4
2
3
3
2
4
1
5
From the above table it is seen that as the price per unit say cotton goes on increasing, the quantity
demanded goes on falling. AS is clear, when price of cotton is Rs. 5, quantity demanded is 1 units. Now,
the price of cotton falls to Rs. 3, the quantity demanded increases to 3 units. Moreover, as the price falls
to Rs. 1 quantity demanded shoots upto 5 units.
Individual Demand Curve
Individual demand curve refers to the quantity demanded by the consumer at different levels of prices.
It can be shown with the help of figure
In the figure given below OX axis measures the different quantities of cotton demanded on OY-axis
price per unit cotton. DD is demand curve. The points a, b, c, d, e on the demand curve shows the price
quantity relationship. At price Rs. 5 the quantity demanded is 1 units. As the price falls to Rs. 1 per unit,
the quantity demanded increases to 5 units. Moreover, the demand curve slopes downward from left to
right which indicates that there is inverse relation between price and quantity demanded.
Diagram
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In table 2, market schedule is obtained by adding the demand of A and B at different prices. For
instance, at a price of Rs. 5 the market demand is 25 i.e. 10 of A consumer and 15 for B consumer. AS
the price falls to Rs. 1 the market demand increases to 65 i.e. 30 and 35 for A and B consumers
respectively. In other words, we can say that like individual demand, market demand also depicts the
negative correlation between price and quantity demanded.
Market Demand Curve
The market demand curve is the horizontal summation of all individuals demand for the commodity.
The above figure and B shows the individual demand curves. D1 D1 and D2 D2are the demand curves for
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consumers A and B and the market demand curve is DD. It is also assumed that there are two
consumers in the market facing same price of the the commodity but they purchase according to their
individual requirements.
A + B = Market Demand
At price Rs. 5 the market demand is
a1 + a2 = a
At price Rs. 4 the market demand is
b1 + b2 = b
In the same fashion, at prices 3, 2, 1, the market demand is
c1 + c2 = c
d1 + d 2 = d
e1 + e2 = e
Now, if we combine these points we will get the market demand curve as DD.
Law of Demand
The law of demand states that there is inverse relation between the price and demand for a commodity.
Although, this relationship is not proportionate yet is does not mean when price falls by one-half the
demand for good will be doubled. It simply shows the direction of change in demand as a result of
change in price.
THE DEMAND CURVE
A demand curve is a graphical presentation of the demand schedule. A demand curve is obtained by
plotting a demand schedule. For example, when the data given in the demand schedule (Table ) is
presented graphically as in Fig. the resulting curve DD is the demand curve. The curve DD in Fig.
depicts the law of demand. It slopes downward to the right. It has a negative slope. The negative slope
of the demand curve DD shows the inverse relationship between the price of shirt and its quantity
demanded. It shows that demand for shirts increases with the decreases in its price and decreases with
rise in its price. As can be seen in Fig. below , downward movement on the demand curve DD from
point D towards D shows fall in price and rise in demand. Similarly, an upward movement from point
D towards D reads rise in price and fall in demand.
(i) Income effect. When price a commodity falls, real income of its consumers increases in terms of
this commodity. In other words, their purchasing power increases since they are required to play less
for the same quantity. According to another economic law, increase in real income (or purchasing
power) increases demand for goods and services in general and for the goods with reduced price in
particular. The increase in demand on account of increase in real income is called income effect.
(ii) Substitution effect. When price of a commodity falls, it becomes cheaper compared to its
substitutes, their prices remaining constant. In other words, when price of a commodity falls, price of
its substitutes remaining the same, its substitute becomes relatively costlier. Consequently, rational
consumers tend to substitute cheaper goods for costlier ones within the range of normal goods- goods
whose demand increases with increase in consumers income-other things remaining the same.
Therefore, demand for the relatively cheaper commodity increases. The increase in demand on account
of this factor is known as substitution effect.
(iii)
Diminishing marginal utility. Marginal utility is the utility derived from the marginal unit a
commodity when its price falls. When a person buys a commodity, he exchanges his money income
with the commodity in order to maximize his satisfaction. He continues to buy goods and services so
long as marginal utility of his money (Mums) is less than the marginal utility of the commodity
(Muc).commodity Mum with Muc, with a view to maximizing his satisfaction. Consequently, demand for a
commodity increase when its price falls.
Assumptions in the law of demand
According to Stigler and Boulding, the law of demand is based on the following assumptions:
1. There should be no change in the income of the consumers.
2. There should be no change in the tastes and preferences of the consumers, because the law of
the demand applies only when the tastes and preferences of the consumers remain constant.
3. Price of the related commodities should remain unchanged.
4. The commodity in questions should be a normal one.
5. There should be no change in the size of population.
6. There distribution of income and wealth should be equal.
7. There should be continuous demand except in case of indivisible commodities.
8. There should be perfect competition in the market.
Importance of the Law
The law of demand has been of great theoretical and practical importance in economics as:
1. Price Determination.
2. Importance for the consumer
3. Importance to Finance Minister
4. Important for Planning.
5. Important for Producers
6. Importance for Farmers
EXCEPTIONS TO THE LAW OF DEMAND
The law of demand is one of the fundamental laws of economics. The law of demand, however, does not
apply to the following cases:
(i) Expectations regarding future prices.
(ii) Prestigious goods.
(iii)
Giffen goods.
Price elasticity of demand
(PED or Ed) is a measure used in economics to show the responsiveness, or elasticity, of the quantity
demanded of a good or service to a change in its price. More precisely, it gives the percentage change in
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quantity demanded in response to a one percent change in price (holding constant all the other
determinants of demand, such as income). It was devised by Alfred Marshall.
Price elasticity of Demand = Proportionate change in purchases of commodity X
Proportionate change in price of commodity X
Types/Degrees of Price Elasticity of Demand
The concept of price elasticity of demand can be used to divide the goods in to three groups.
(i) Elastic. When the percent change in quantity of a good is greater than the percent change in its
price, the demand is said to be elastic. When elasticity of demand is greater than one, a fall in price
increases the total revenue (expenditure) and a rise in price lowers the total revenue
(expenditure).
(ii) Unitary Elasticity. When the percentage change in the quantity of a good demanded equals
percentage in its price, the price elasticity of demand is said to have unitary elasticity. When
elasticity of demand is equal to one or unitary, a rise or fall in price leaves total revenue unchanged.
(iii) Inelastic. When the percent change in quantity of a good demanded is less than the percentage
change in its price, the demand is called inelastic. When elasticity of demand is inelastic or less than
one, a fall in price decreases total revenue and a rise in its price increases total revenue.
Methods to measure Price Elasticity of demand
There are three methods of measuring price elasticity of demand:
(1) Total Expenditure Method.
(2) Geometrical Method or Point Elasticity Method.
(3) Arc Method.
Point Method or Geometrical Method:
This method was also suggested by Alfred Marshall. It explains the elasticity of demand at a particular
point of the demand curve if the demand function is linear one (or when demands curve is straight line
sloping down from left to right). The point method is not applicable on curvilinear demand curves. This
method is based on the proposition that each point of the straight line demand curve has different
elasticity of demand. Different elasticity of demand. We have already shown (under the heading slope
and elasticity) that every point on demand curve does not have the same elasticity. This has been
explained by point method, also known as Geometrical Method. The basic formula for this method is :
Ep = Length of Lower segment
Length of Upper segment
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Now we can calculate elasticity of demand at different points R,A,Q, B and P, As per the ratio of the
lower part to upper part.
=
QP
QR
=1
ep at A =
AP
AR
<1
ep at Q
ep at B =
BP
RB
>1
ep at R =
RP
0
ep at P =
0
RP
Therefore, we can say that at the mid-point on a straight line demand curve, elasticity will be unitary, at
higher points (such as A and R) elasticity will be greater than one; at lower points (B and P) the
elasticity will be less than one. At points R and P the elasticities will be infinite and zero respectively.
Point method is very useful in economics. It helps us measuring elasticity with very small changes in
price and quantity demanded. It also tells us that slope and elasticity are two different things.
Arc Method:
As we have seen that point elasticity method can be used to determine the elasticity of demand at
different points when infinitesimal changes in price are taking place. If the price change is somewhat
large or we have to measure elasticity between two different points rather than at a specific point we
use Arc Method. When we have to measure the price elasticity over an arc of the demand curve, such as
between points Q and Q1 on the demand curve in figure the point elasticity method cannot yield true
picture. In measuring arc elasticity we use the average of the two prices and average of two quantities
at these prices in the following manner.
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Suppose commodity Xs position is like this- At price of Rs. 10 (P1) its, quantity demanded is 100 (Q1)
and at price of Rs. 5 (P2) its quantity demanded is 300 (Q2). The elasticity of demand as per Arc Method
will be
q
ed = p
p1+p2
q1+q2
= 200 10 + 5
5
300+100
5
100 + 300
= 200 15 = 1.5
5
400
Total Expenditure Method/Total Revenue Method:
The price elasticity can be measured by noting the changes in total expenditure brought about by
changes in price and quantity demanded.
(i) When with a percentage fall in price, the quantity demanded increases so
much that it results in the increase in total expenditure, the demand is said to be elastic (Ed > 1).
For Example:
Price Per Unit (Rs.)
20
10
Quantity Demanded
10 Pens
30 Pens
unrelated. A change in the price of a related good causes the demand curve to shift reflecting a change
in demand for the original good. Cross price elasticity is a measurement of how far, and in which
direction, the curve shifts horizontally along the x-axis. A positive cross-price elasticity means that the
goods are substitute goods.
Cross elasticity of Demand for X and Y = Proportionate change in purchases of commodity X
Proportionate change in price of commodity Y
The numerical value of cross elasticity depends on whether the two goods in question are
substitutes, complements or unrelated.
Types of Cross Elasticity
(i) Substitute Goods. When two goods are substitute of each other, such as coke and Pepsi, an
increase in the price of one good will lead to an increase in demand for the other good. The
numerical value of goods is positive.
For example there are two goods. Coke and Pepsi which are close substitutes. If there is increase in
the price of Pepsi called good y by 10% and it increases the demand for Coke called good X by 5%,
the cross elasticity of demand would be:
Exy = %qx / %py = 0.2
Since Exy is positive (E > 0), therefore, Coke and Pepsi are close substitutes.
(ii) Complementary Goods. However, in case of complementary goods such as car and petrol,
cricket bat and ball, a rise in the price of one good say cricket bat by 7% will bring a fall in the
demand for the balls (say by 6%). The cross elasticity of demand which are complementary to each
other is, therefore, 6% / 7% = 0.85 (negative).
(iii) Unrelated Goods. The two goods which a re unrelated to each other, say apples and pens, if
the price of apple rises in the market, it is unlikely to result in a change in quantity demanded of
pens. The elasticity is zero of unrelated goods.
SUPPLY AND ELASTICITY OF SUPPLY
Meaning of Supply
Supply means the quantities of goods which are offered for sale at particular prices during a giver
period of time. Thus, the supply of a commodity may be defined as the amount of that commodity which
the sellers (or producers) are able and willing to offer for sale a particular price during a certain period
of time.
Factors Affecting Supply
The determinants of supply, other than price, are as follows:
1)
Price.
2)
Prices of related goods.
3)
Objectives o producer
4)
Infrastructure
5)
The cost of factors of production
6)
The State of Technology
7)
Factors Outside the Economic Sphere.Weather conditions, floods and droughts, epidemics
etc.
8)
Tax and Subsidy
Statement of the Law
Law of supply may be stated as Other things remaining unchanged, the supply of a commodity
expends (i.e., rise) with a rise in its price, and contracts (i.e. falls) with a fall in its price.The law, thus,
suggests that the supply varies directly with the changes in price. So, a larger amount is supplied at a
higher price than at a lower price in the market.
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1
2
3
4
5
5
10
15
20
25
Elasticity of Supply
Elasticity of supply may be defined as the ration of the percentage change or the proportionate
change in quantity supplied to the percentage or proportionate change in price. In symbolic terms;
q
Es = p
p1
q1
Where es represents elasticity of supply, Q stands for quantity supplied, P for price and the symbols
indicates a change.
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There are various degrees of elasticity of supply. It may be relatively elastic, relatively or may have
perfect elasticity or inelasticity. Different types of supply elasticities have been illustrated in Figure
The panel (a) of Fig. represents the supply curve of zero elasticity. Irrespective of the price, the
producer would be supplying OC quantity (es = O). The panel (b) represents the supply curve of infinite
elasticity, at OP price the producer would be supplying any amount of the commodity (es = )
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2. Total Variable Cost (TVC):- Those costs vary with the production of a commodity during short
period and have direct relation with the change in production a called total variable costs (TVC).
These costs are also called prime cost are direct costs. It increases with increase in production of
output.
3. Total Cost:- Aggregate of total fixed cost and total variable cost increased by a firm in the
production of any commodity is called total cost.
Total cost (TC) = Total Fixed cost + Total Variable Cost (TVC)
Total cost increases with change in output.
AVERAGE OR PER UNIT COST
1.
Average Fixed Cost:- Average fixed cost is total fixed cost divided by the volume of output. AFC
has inverse relation with output and it decreases with increase and increases with decrease in
output. AFC curve in rectangular hyperbola in shape.
AFC = TFC / Output
i.e.
2.
Average Variable Cost (AVC):- Average variable cost is total variable cost divided by the
volume of output. AVC falls with increase in output reaches its minimum and then starts rising.
It is due to operation of law of returns. Shape of AVC curve is U shaped because of operation of
law of returns where at 1st stage i.e. during law of increasing returns production rises and cost
decreases then at 2nd stage i.e. laws of constant & diminishing returns cost reaches at minimum
and remains constant and at 3rd stage i.e. law of negative returns cost starts increasing.
AVC = TVC / Output
i.e.
3.
Average Costs (AC):- Average cost or average total cost (ATC) is the aggregate of AFC & AVC.
AC = TC / Output
i.e. = Total cost / Output
Or
AC = AFC + AVC
AC curve decreases with increase in output remains constant up to a point and then
increases with increase in output.
4.
Marginal Cost (MC):- Marginal cost is additional cost incurred in producing an additional unit
of output.
MC = TC / Output
Marginal cost changes with the change in AVC and is independent of fixed cost. MC falls in
beginning reaches at its minimum and there after rises. MC is also a U shaped curve.
Total Cost
Average Costs
Output
TFC
TVC
TC
AFC
AVC
AC
MC
0
100
0
100
0
0
0
--1
100
30
130
100
30
130
30
2
100
60
160
50
30
80
30
3
100
80
180
33.3
26.7
60
20
4
100
90
190
25
22.5
47.5
10
5
100
100
200
20
20.0
40.0
10
6
100
120
220
16.66
20.0
36.6
20
7
100
150
250
14.3
21.4
35.7
30
8
100
190
290
12.5
23.7
36.2
40
9
100
240
340
11.1
26.6
37.7
50
10
100
320
420
10
32.0
42.0
80
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In above table TFC remains constant and TVC goes on increasing and TC is also increasing with
increase in output. AFC is decreasing with increase in output. AVC decreases reaches to minimum and
then increasing. AC decreases reach to minimum and then increase. MC decreases reach to minimum
remains constant and then increases.
DIAGRAM 1st
Output (In Units)
TFC remains constant weathers production is zero or 10units. TVC starts from O units and increases
with increase in output. TC is the total of TVC and TFC.
AC, MC and AVC are U shaped curves because of the operations of law of returns. AFC curve shows a
decreasing trend. MC curve passes through minimum point, point of AC and AVC.
RELATIONSHIP BETWEEN AC AND MC
MC
(1)
(2)
(3)
AC
AC and MC fall in beginning but MC falls more rapidly than AC and MC is below AC or vice versa
(AC > MC).
When AC rises MC also rises but rises rapidly than AC and MC is more than AC or vice versa.(MC
> AC)
When AC is minimum it is equal to MC curve cuts AC curve at its minimum point.(MC=AC)
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LMC
LTC
Q
LMC
LAC
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Relation between long-run marginal cost and long-run average cost is similar to that of what it
is in short run AC and MC. The only difference in long run AC and MC is that long run MC and AC curve
are more flat to than that of SAC and SMC, it is so because in long run all factors of production are
variable and firm selects appropriate scale of production at minimum cost so cost increase in long run
is gradual in comparison to short run curves. LAC is also a expanded U Shaped curve because of
operation of laws of returns to scale.
As firm expend their output scale of operation also increased by firm so they will enjoy economies of
scale but if these firm produce beyond their installed capacity of scale that results in increase in cost
gradually.
CONCEPTS OF REVENUE
In economics revenue is studied in terms of total revenue (TR), Average revenue (AR) and
marginal revenue (MR).
Total Revenue:- Total revenue is the total money receipts of a firm or producer with sales of its
output.
TR
=
QxP
i.e. quantity of goods sold x price per unit.
Average Revenue:- It is average pr unit of sale of output. It is also called. Price per unit of output.
AR
=
TR / O
i.e. total revenue / No. of output sold.
Marginal Revenue:- It is an addition to the total revenue when an additions unit of output is sold by a
firm.
MR
=
TR / R
TR =
Change in Total Revenue
O
=
Change in Output
or
MR
=
TR n TR n-1
TR
=
Total Revenue
TRn
Total Revenue of n products
=
TRn-1 =
Total Revenue of n-1 products.
Units of output
sale
1
2
3
4
5
6
7
8
MR
12
10
8
6
4
2
0
-2
Table shows that with increase in output unit sale price per unit decreases and TR increases
reaches to maximum remains constant and declines. AR falls with every unit of output sold and is equal
to price. MR will also decrease at increasing rate reaches to0 and then becomes negative. AR and MR is
decreasing but AR is positive and MR has three trends decreases, becomes zero and negative. Fall in AR
is less than MR (AR > MR) when MR is O then TR will be at its maximum.
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TR, AR and MR are revenue curves shown on OY axis output is shown on OX axis. A to B is
increasing stage of TR. B to C is constant and C to D is decreasing stage of TR. AR and MR are falling but
AR is above the MR (AR > MR). MR will be negative when TR falls.
Relation between AR and MR
Under different market conditions the relation between AR and MR can be as given below:
AR and MR under perfect Competition
Under perfect competition price remains constant. Price, AR and MR will be the same and the
demand curve will be horizontal to OX-axis because there is a large number of buyers and sellers,
homogeneous product and price is determined by the total demand and supply, firm is a price taker,
Hence, there is one price prevailing in the market. It can be seen from the following table:AR and MR under Perfect competition
----------------------------------------------------------------------------------------------------------------------------------Units of Output
Price per Unit (Rs.)
TR (Rs.)
AR (Rs.)
MR (Rs.)
----------------------------------------------------------------------------------------------------------------------------------1
5
5
5
5
2
5
10
5
5
3
5
15
5
5
4
5
20
5
5
5
5
25
5
5
6
5
30
5
5
----------------------------------------------------------------------------------------------------------------------------------The table reveals that the price per unit is the same and TR is increasing but AR and MR remain
constant. Price is equal to AR and MR (P=AR=MR) under perfect competition. The table can be shown
on a diagram as given below:
(Diagram: AR and MR under Perfect Competition) The diagram shows that price is determined by
the intersection of demand and supply by the industry and the same is accepted by individual firm.
Price, MR
and AR are shown by the horizontal line parallel to OX axis.
AR and MR under imperfect Competition
As we have seen that perfect competition is an imaginary and unrealistic situation. It is called a
myth. Under imperfect competition the firm can increase its sales by reducing the price of its product.
Hence, AR and MR will be different under this market structure. It can be seen from the following
table:-
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Types of Market
Perfect Competition
Imperfect Competition
1.
2.
3.
4.
Monopoly
Duopoly
Monopolistic competition
Oligopoly
PERFECT COMPETITION
What is Perfect Competition?
Perfect Competition is a market structure where there is a perfect degree of competition and single
price prevails. The concept of Perfect Competition was introduced by Dr. Alfred Marshall.
Nothing is 100% perfect in this world. So, this states that perfect competition is only a theoretical
possibility and it does not exist in reality.
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5. Elements of monopoly
6. Price rigidity
7 Product is Standardized ( eg: car industry)
Meaning of Duopoly
Duopoly is exactly a special case of thesis of Oligopoly, in which there are two sellers involved and are
absolutely at liberty and no contract persists between them. Notwithstanding their liberations, the
variations in price and productivity of one will affect the other one indeed and the subsequent reactions
are to follow. One seller nevertheless presumes that his competition is impassive by his activity; in that
case he takes only his own leading persuasion on the price of that commodity.
Alternatively, every seller among the two will considers the consequence of his policy on that of his
competition and the response of the competition on himself once more then he takes into account both
straight and meandering power upon the price of that commodity. Furthermore, a competitive sellers
policy may stay untouched either to the sum proffered for sale or to the price at which he offers his
product. In this way the complexity of duopoly can be regarded as either avoiding mutual liberty or
identifying it.
Cournots Model of Duopoly
This model is the ancient models of determining duopoly complexities. Cournots Model is based
on the following postulations.
Postulations
1. There are two sellers at liberty. Conversely, mutually dependence of the duopolists is ignored.
2.
They manufacture and sell standardised goods.
3. The total productivity has to be sold out, being non-durable and non-warehoused.
4. The number of consumers is huge.
5. Each seller among the two is very well aware of the market demand curve of the commodity.
6. The cost of manufacturing is presumed to be zilch.
7. Every of the two industries have like costs and like demands.
8. Every of the two sellers fixes on about the volume he wants to manufacture and sell in each
product.
9. But both the sellers are unaware of the competitive strategies of each other regarding the
productivity.
10. At the same time each seller takes the supply or productivity of its competitor as invariable.
11. Neither of both decides the price for their commodities but each accepts the market demand price
at which the commodity can be sold.
12. The entry of firm is blocked.
13. Each seller aims at obtaining the maximum net revenue or profit.
Economies of Scale
Economies of Scale are the results of the operation of laws of returns to scale in long run. They are of
two types :
(1)
Internal economies of scale.
(2)
External economies of scale
(1) Internal Economies: - Internal economies of scale are those economies which are on account of
the size and operations of an individual firm itself and not from the outside factors. These economies
may be of following categories:(i)
Managerial economies means that with the expansion of the output on account of the change in
scale of production the whole expanded scale is looked after by the personnel in the organizations and
administrative cost decreases with the increase in output.
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(ii) Marketing economies are concerned with the bulk purchases of raw material while producing
on the large scale leads to decrease in the cost of production. Selling in lot saves time, money and
energy. Transportation cost will also be reduced.
(iii) Specialization economies are on account of division of labour and specialization when large
scale production is carried on. The cost of production reduces due to specialization when large scale
production is carried on. The cost of production reduces due to specialization and division of labour in
a business firm.
(iv) Technical economies arise on account of large scale production in the use of plant, machinery
and work processes. Advanced technology is used which reduces the cost of production when the
production is carried on large scale.
(2) External Economies :- External economies arise on account of the external factors and they are
enjoyed by all the firms in the area or industry as a whole. When an area is industrially well developed
then there will be development of labour market, banking, insurance, financial institutions, means of
communication and transportation, social overhead and cheap water, electricity and ancillaries. When a
new firm or new industrial unit is set up all these benefits will be available in that area. All these
facilities will reduce the cost of production o fall the industrial units in the area.
As a result of all the internal and external economies the unit cost of production falls and the
LAC and LMC will also fall.
Diseconomies of Scale
Diseconomies means the losses incurred by the firms or industrial units in an area. These diseconomies
are of two types:
(1)
Internal diseconomies of scale.
(2)
External diseconomies of scale
(1) Internal Diseconomies: - These diseconomies are concerned with the size and operation of
individual firm or industry. These diseconomies are of the following categories:(i)
Managerial diseconomies.
(ii)
Technical diseconomies.
(iii)
Marketing diseconomies.
(iv)
Specialization diseconomies.
When the size of operation of a firm increases, the span of control becomes large and thereby the
employer-employee relations are adversely affected leading to increase in the cost of production. It is
resulted into managerial diseconomies.
Under technical diseconomies when the output is taken on large scale after a given point the break
down rate may increase the cost of production.
Marketing diseconomies arise on account of the adverse effect on the control and coordination over
marketing activities because of the large scale production and it increases the cost of production.
Specialization diseconomies are concerned with the division of labour and specialization introduced
by a firm with the by a firm with the operation of the large scale production. But after a point due to
monotony, fatigue and lack of coordination between different layers of personnel administration the
cost of production increases that given birth to these diseconomies.
(2) External Diseconomies: - Such loss or external diseconomies are incurred by business firms or
industrial units in an area. Concentration and localization of industries adversely affect the industrial
peace in that area and strikes, lockouts, go slow tactics, gheraos, industrial accidents, emergence of
dirty colonies, Water pollution, air pollution, etc/ increase the cost of production of all firms and
industrial units. Means of communication and transportation are overburdened.
Hence, the internal and external diseconomies will increase the LAC curve and LMC curve upward and
the cost will increase.
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UNIT-III
MEANING & DEFINITION OF NATIONAL INCOME
Marshalls Definition
"The labour and capital of country acting on its natural resources produce annually a certain net
aggregate of commodities, material and immaterial, including services of all kinds. This is the true net
annual income or revenue of the country or national dividend."
The main defects of marshall's definition are as under
1. A country produces a number of commodities and services whose correct evalution becomes
difficult. Thus, we cannot get an accurate estimate of the national income of a country.
2. There are some commodities which are used more than once. Thus, there is a possibility that the
product of such commodities may be counted twice. This will give a wrong estimate of the national
income.
3. There are some commodities which do not appear in the market and they are consumed directly by
the producers. This normally happens in the case of agricultural commodities. Marshall's definition fails
to provide a measure for such items.
Pigous Definition
"National income is that part of the objective income of the community, including of course income
derived from abroad, which can be measured in money."
The limitations of this definition are as following:
1. While calculating national income, Pigou includes only those goods and services which are exchanged
for money. Thus, the services which a person renders to himself, and those which he performs for the
sake of his family or friends should not be regarded as part of national dividend. Thus, the definition
does not provide a correct picture of the national income of a country.
2. This definition is applicable only to developed countries of the world where barter system is not
found. It cannot be used to calculate of the national income of the backward and less developed
countries where the barter system still occupies an important place in the economy.
Importance of National Income
The computation of national income is one of the very important statistics for a country. It has several
important uses and therefore there is a great need for their regular preparation. The following are
some of the important uses of national income statistics:
1) Level of Economic Welfare
The national income estimate reveals the overall performance of the country during a given
financial year. With the help of this statistics the per capita income i.e. the income earned by
every individual is calculated. It is obtained by dividing the total national income by the total
population. With this we come to the level of economic welfare in terms of its standard of living.
2) Rate of Economic Growth
With the help of national income statistics we can know whether the economy is growing or
declining. In simple words it helps us to know the conditions of a country economy. If the
national income is growing over a period of year it means that the economy is growing and if
the national income has reduced as compares to the previous it reveals that the economy is
detraining. Similarly the growing per capita income shows an increasing standard o living of the
people which is a positive sign of a nations growth and vice versa.
3) Distribution of Wealth
One of the most important objectives that is achieved after calculating national income is to
check its distribution among different categories of income such as wages, profits, rents and
interest. It helps to understand that how well the income is distributed among the various
factors of the economy and their distribution among the people as well.
4) Ease in Planning
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Since the national income estimates also contain the figures of saving, consumption and
investment in the economy so it proves to be a valuable guide to economic policy relating to
planning and active government intervention in the economy. The estimates are used as a data
for future planning also.
5) Formation of Budget
Budget is an effective tool for planning and control. It is prepared in the light of the information
regarding consumption, saving, and investment which are all provided by the national income
estimates. Further we can asses and evaluate the achievements or otherwise of the
development targets laid down in the plans from the changes in national income and its various
components.
6) Conclusion
Thus we may conclude that national income statistics chart the movement of a country from
depression to prosperity its rate of economic growth and its standard of living in comparison
with rest of the world.
CONCEPTS OF NATIONAL INCOME
There are different concepts of National Income, namely; GNP, GDP, NNP, Personal Income and
Disposable Income.
1) Gross Domestic Product (GDP): GDP at market price is sum total of all the goods and services
produced in a country during a year within the domestic territory
2) Gross National Product (GNP): GNP at market price is sum total of all the goods and services
produced in a country during a year and net income from abroad. GNP is the sum of Gross Domestic
Product at Market Price and Net Factor Income from abroad
3) GDP at Market Price: If we multiply the total output produced in one year within the domestic
territory , by their Market Prices, we get GDP at market price.
4) GNP at Market Price : If we multiply the total output produced in one year within the domestic
territory as well as outside the country , by their Market Prices, we get GNP at market price.
5) Gross Domestic Product at Factor Cost : The gross domestic product at factor cost is the
difference between gross domestic product at market price and net indirect taxes.
6) Gross National Product at Factor Cost : The gross national product at factor cost is the difference
between gross national product at market prices and net indirect taxes.
Private Income
Central Statistical Organization defines Private Income as the total of factor income from all sources
and current transfers from the government and rest of the world accruing to private sector or in other
words the private income refers to the income from socially accepted source including retained income
of corporation.
NI+ Transfer payment + Interest on public debt +Social security + Profit and Surplus of public
enterprises = Private Income
Personal Income
Prof. Peterson defines Personal Income as the income actually received by persons from all sources in
the form of current transfer payments and factor income. In other words, Private Income is the Total
income received by the citizens of a country from all sources before direct taxes in a year.
PI = Private Income + Undistributed Corporate Profits Direct Taxes
Disposable Income
Prof. Peterson defined Disposable Income as the income remaining with individuals after deduction of
all taxes levied against their income and their property by the government.
Disposable Income refers to the income actually received by the households from all sources. The
individual can dispose this income according to his wish, as it is derived after deducting direct taxes.
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1)
2)
3)
4)
5)
6)
7)
8)
9)
10)
11)
12)
13)
14)
Capital gains or losses Commodity product this year is sold next year if at higher price is
capital gain & at loss then capital losses e.g. other example could be selling of shares.
Income earned through illegal activities Such as gambling or illicit extortion cannot be
included in national income.
Self-consumed production In many backward countries, substantial part of the output is not
exchanged for money in market it is being either consumed directly by producer or bartered for
other goods & services in the unorganized sector.
Paucity of statistics According to the national income committee of India, the available
statistics, especially for agriculture & small scale industry are extremely unreliable &
incomplete.
Inflation may give a false impression of growth in national income In a country when
price rise, inflation rises even though the production falls & vice versa. It leads to mismeasurement of national income. ,
Difficulties in classifying the commodities Coal is both household use & industrial use as
well ,so is the expenditure on coal consumption , expenditure or an investment.
Multiple occupations The production in agri-industrial, in all sectors is highly scattered and
unorganized making the calculation of national income very difficult.
Capital depreciation Depreciation is charged on profit which lowers national income. But the
problem of estimating the current depreciated value of a piece of capital whose expected life is
forty year is very difficult.
Data problems There are problems of collecting reliable statistical data abort all the
productive activities in the underdeveloped countries.
Illiteracy The majority of people in the country like India are illiterate & they do not keep any
accounts about the production & sole of their products.
10. He advised several monetary controls for the central bank, which in turn will act as the
instrument of controlling cyclical fluctuations.
11. Keynesian theory has played a vital role in the economic development of lessdeveloped countries.
12. He rejected the theory of wage-cut as a means of promoting full-employment.
13. Keynes theory has given rise to the importance of social accounting or national
income accounting.
SAYS LAW OF MARKET
1)
Says Law is the foundation of classical economics. Assumption of full employment as a
normal condition of a free market economy is justified by classical economists by a law known
as Says Law of Markets. It was the theory on the basis of which classical economists thought
that general over-production and general unemployment are not possible.
2)
Says law states that the production of goods creates its own demand
exchange it for some other product which he desires therefore the very act of supplying goods
implies a demand for them. In such a situation there cannot be general overproduction
because the supply of goods will not exceed demand as a whole.
4. Saving investment Equality: Income occurring to the factors owners in the form of rent,
wages and interest is not spent on consumption but some proportion out of it is saved which is
automatically invested for further production.
5. Rate of interest as a determinant factor: If there is any gap between saving and
investment, the rate of interest brings about the equality between two
6. Flexibility between interest and wage rate: The theory assumes the part of income is
saved and available for investment. If at any point of time saving is more then investment, the
rate of interest will fall, which will result in low savings and more investments. At a lower rate
of interest, household will like to save less, where as producers will like or invest more and
economy will be in equilibrium.If there are unemployed persons in an economy, wage rate will
fall. This will induce entrepreneurs to demand more labor. Ultimately all labor will be
absorbed. The economy will be in full employment equilibrium.
This view suggests that the key to economic growth is not increasing demand, but increasing
production. Says views were expanded on by classical economists, such as James Mill and
David Ricardo.
Pigous Formulation of Says law
1. According to Professor Pigou, the unemployment which exists at any time is because of
the fact that changes in demand conditions are continually taking place and that frictional
resistances prevent the appropriate wage adjustment from being made instantaneously.
2.
Thus, according to classical theory, there could be small amounts of frictional
unemployment attendant on changing from one job to another but there could not be
involuntary unemployment for a long period.
3.
According to Professor Pigou, if people were unemployed, wages would fall until all
seeking employment were in fact employed.
4.
Involuntary unemployment which was found at times of depression was because of the
fact that wages were kept too high by the actions of labour unions and governments.
Therefore, Professor Pigou advocated that a general cut in money wages at a time of
depression would increase employment.
5.
According to Pigou, perfectly elastic wage policy would abolish fluctuations of
employment and would ensure full employment.
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Unit-IV
What is Trade Cycle? Meaning
The alternating periods of expansion and contraction in the economic activity has been called business
cycles or trade cycles.
The period of high income, high output and high employment is called as the Period of Expansion,
Upswing or Prosperity.
The period of low income, low output and low employment is called as the Period of Contraction,
Recession, Downswing or Depression.
Definition of Trade Cycle
According to Keynes,
"A trade cycle is composed of periods of Good Trade, characterized by rising prices and low
unemployment percentages, shifting with periods of bad trade characterized by falling prices and high
unemployment percentages."
1.
2.
3.
4.
5.
6.
7.
8.
9.
1.
2.
3.
4.
1.
2.
3.
4.
5.
6.
7.
8.
Business Cycle (or Trade Cycle) is divided into the following four phases :Prosperity Phase : Expansion or Boom or Upswing of economy.
Recession Phase : from prosperity to recession (upper turning point).
Depression Phase : Contraction or Downswing of economy.
Recovery Phase : from depression to prosperity (lower turning Point).
The business cycle starts from a trough (lower point) and passes through a recovery phase followed by
a period of expansion (upper turning point) and prosperity. After the peak point is reached there is a
declining phase of recession followed by a depression. Again the business cycle continues similarly with
ups and downs.
Explanation of Four Phases of Business Cycle
The four phases of a business cycle are briefly explained as follows :1. Prosperity Phase
When there is an expansion of output, income, employment, prices and profits, there is also a rise in the
standard of living. This period is termed as Prosperity phase.
The features of prosperity are :High level of output and trade.
High level of effective demand.
High level of income and employment.
Rising interest rates.
Inflation.
Large expansion of bank credit.
Overall business optimism.
A high level of MEC (Marginal efficiency of capital) and investment.
Due to full employment of resources, the level of production is Maximum and there is a rise in GNP
(Gross National Product). Due to a high level of economic activity, it causes a rise in prices and profits.
There is an upswing in the economic activity and economy reaches its Peak. This is also called as a
Boom Period.
2. Recession Phase
The turning point from prosperity to depression is termed as Recession Phase.
During a recession period, the economic activities slow down. When demand starts falling, the
overproduction and future investment plans are also given up. There is a steady decline in the output,
income, employment, prices and profits. The businessmen lose confidence and become pessimistic
(Negative). It reduces investment. The banks and the people try to get greater liquidity, so credit also
contracts. Expansion of business stops, stock market falls. Orders are cancelled and people start losing
their jobs. The increase in unemployment causes a sharp decline in income and aggregate demand.
Generally, recession lasts for a short period.
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1.
2.
3.
4.
5.
6.
7.
8.
3. Depression Phase
When there is a continuous decrease of output, income, employment, prices and profits, there is a fall in
the standard of living and depression sets in.
The features of depression are :Fall in volume of output and trade.
Fall in income and rise in unemployment.
Decline in consumption and demand.
Fall in interest rate.
Deflation.
Contraction of bank credit.
Overall business pessimism.
Fall in MEC (Marginal efficiency of capital) and investment.
In depression, there is under-utilization of resources and fall in GNP (Gross National Product). The
aggregate economic activity is at the lowest, causing a decline in prices and profits until the economy
reaches its Trough (low point).
4. Recovery Phase
The turning point from depression to expansion is termed as Recovery or Revival Phase.
During the period of revival or recovery, there are expansions and rise in economic activities. When
demand starts rising, production increases and this causes an increase in investment. There is a steady
rise in output, income, employment, prices and profits. The businessmen gain confidence and become
optimistic (Positive). This increases investments. The stimulation of investment brings about the
revival or recovery of the economy. The banks expand credit, business expansion takes place and stock
markets are activated. There is an increase in employment, production, income and aggregate demand,
prices and profits start rising, and business expands. Revival slowly emerges into prosperity, and the
business cycle is repeated.
Thus we see that, during the expansionary or prosperity phase, there is inflation and during the
contraction or depression phase, there is a deflation
What is Inflation? Meaning
1) Inflation refers to a continuous rise in general price level which reduces the value of money or
purchasing power over a period of time.
2) Statistically speaking, inflation is measured in terms of a percentage rise in the price index (i.e.
percentage rate per unit time) usually for an annum (a year) or for 30-31 days (a month).
Definition of Inflation
According to Crowther,
"Inflation is a state in which the value of money is failing i.e. the prices are rising."
According to Coulbourn,
"Inflation is too much of money chasing too few goods."
1.
2.
3.
4.
5.
6.
7.
8.
9.
Features of Inflation
The characteristics or features of inflation are as follows :Inflation involves a process of the persistent rise in prices. It involves rising trend in price level.
Inflation is a state of disequilibrium.
Inflation is scarcity oriented.
Inflation is dynamic in nature.
Inflationary price rise is persistent and irreversible.
Inflation is caused by excess demand in relation to supply of all types of goods and services.
Inflation is a purely monetary phenomenon.
Inflation is a post full employment phenomenon.
Inflation is a long-term process.
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1.
2.
3.
4.
5.
6.
2. Post-War Inflation : Inflation that takes place soon after a war is known as Post-War Inflation. After
the war, government controls are relaxed, resulting in a faster hike in prices than what experienced
during the war.
3. Peace-Time Inflation : When prices rise during a normal period of peace, it is known as Peace-Time
Inflation. It is due to huge government expenditure or spending on capital projects of a long gestation
(development) period.
Types of Inflation on Government Reaction
Types of inflation on basis of Government's reaction or its degree of control:1. Open Inflation : When government does not attempt to restrict inflation, it is known as Open Inflation.
In a free market economy, where prices are allowed to take its own course, open inflation occurs.
2. Suppressed Inflation : When government prevents price rise through price controls, rationing, etc., it
is known as Suppressed Inflation. It is also referred as Repressed Inflation. However, when
government controls are removed, Suppressed inflation becomes Open Inflation. Suppressed Inflation
leads to corruption, black marketing, artificial scarcity, etc.
1.
2.
3.
4.
5.
6.
7.
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
11.
12.
13.
14.
15.
16.
17. Cost-Push Inflation : When prices rise due to growing cost of production of goods and services, it is
known as Cost-Push (Supply-side) Inflation. For e.g. If wages of workers are raised then the unit cost of
production also increases. As a result, the prices of end-products or end-services being produced and
supplied are consequently hiked.
Types of Inflation on Expectation
Types of inflation on the basis of expectation or predictability:1. Anticipated Inflation : If the rate of inflation corresponds to what the majority of people are expecting
or predicting, then is called Anticipated Inflation. It is also referred as Expected Inflation.
2. Unanticipated Inflation : If the rate of inflation corresponds to what the majority of people are not
expecting or predicting, then is called Unanticipated Inflation. It is also referred as Unexpected
Inflation.
Ill effects of of Inflation
1. Impact of Inflation on Savers: When inflation is high, people may lose confidence in money as the real
value of savings is severely reduced. Savers will lose out if interest rates are lower than inflation
leading to negative real interest rates. This has certainly happened in the UK during 2009-2011.
2. Inflation Expectations and Wage Demands: Price increases lead to higher wage demands as people
try to maintain their real living standards. This process is known as a wage-price spiral.
3. Arbitrary Re-Distributions of Income: Inflation tends to hurt people in jobs with poor bargaining
positions in the labour market - for example people in low paid jobs with little or no trade union
protection may see the real value of their pay fall. Inflation can also favour borrowers at the expense of
savers as inflation erodes the real value of existing debts.
4. Business Planning and Investment: Inflation can disrupt business planning. Budgeting becomes
difficult because of the uncertainty created by rising inflation of both prices and costs - and this may
reduce planned investment spending.
5. Competitiveness and Unemployment: Inflation is a possible cause of higher unemployment in the
medium term if one country experiences a much higher rate of inflation than another, leading to a loss
of international competitiveness and a subsequent worsening of their trade performance.
Benefits of inflation
1. Higher revenues and profits: A low stable rate of inflation of say between 1% and 3% allows
businesses to raise their prices, revenues and profits, whilst at the same time workers can expect to see
an increase in their pay packers. This can give psychological boost and might lead to rising investment
and productivity.
2. Tax revenues: The government gains from inflation through what is called fiscal drag effects. For
example many indirect taxes are ad valorem in nature, e.g. VAT at 20% - so as prices rise, so does the
amount of tax revenue flowing into the Treasury.
3. Cutting the real value of debt: Low stable inflation is also a way of helping to reduce the real value of
outstanding debts there are many home owners with huge mortgages who might benefit from a
period of inflation to bring down the real burden of their mortgage loans. The government too might
welcome a period of higher inflation given the huge level of public sector debt!
4. Avoiding deflation: Perhaps one of the key benefits of positive inflation is that an economy can
manage to avoid some of the dangers of a deflationary recession
MEASURES TO CONTROL INFLATION
The various methods to control inflation are given below however the most common ones are
Monetary and Fiscal Policies:
1. Monetary Policy
With growth of 3.8%, demand in the economy could be growing faster than capacity can grow to meet
it. This leads to inflationary pressures. We can term this demand pull inflation. Therefore, reducing the
growth of Aggregate demand, should reduce inflationary pressures.
Monetary policy is the policy of the central bank of the country, which is the supreme monetary and
banking authority in a country. The central bank may use such methods as the bank rate, open market
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operations, the reserve ratio and selective controls in order to control the credit creation operation of
commercial banks and thus restrict the amounts of bank deposits in the country. This is known as tight
money policy. Monetary policy to control inflation is based on the assumption that a rise in prices is due
to a larger demand for goods and services, which is the direct result of expansion of bank credit. To the
extent this is true, the central banks policy will be successful.
Monetary policy may not be effective in controlling inflation, if inflation is due to cost-push factors.
Monetary policy can only be helpful in controlling inflation due to demand-pull factors.
Let us see how increasing the rate can help control inflation
A higher interest rate should also lead to higher exchange rate, which helps to reduce inflationary
pressure by
Making imports cheaper.
Reducing demand for exports and
Increasing incentive for exporters to cut costs.
2. Fiscal Policy
It is the policy of a government with regard to taxation, expenditure and public borrowing. It has a very
important influence on business and economic activity. Taxes determine the size or the volume of
disposable income in the hands of the public. The proper tax policy to control inflation will avoid tax
cuts, introduce new taxes and raise the rates of existing taxes. The purpose being to reduce the volume
of purchasing power in the hands of the public and thus reduces their demand. A precisely similar
effect will be achieved if voluntary or compulsory savings are increased. Savings will reduce current
demand for goods and thus reduce the inflationary rise in prices.
As an anti-inflationary measure, government expenditure should be reduced. This indicates that
demand for goods and services will be further reduced. This policy of increasing public revenue
through taxation and decreasing public expenditure is known as surplus budgeting. However, there is
one important difficulty is this policy. It may be easy to increase revenue in times of inflation when
people have more money income, but difficult to reduce public expenditure.
During war times as well as during a period of development, it is absolutely impossible to reduce the
planned expenditure. If the government has already taken up a scheme or a group of schemes, it is
ruinous to give them up in the middle. Therefore, public expenditure cannot be used as an antiinflationary measure. Lastly, public debt, i.e., the debt of the government may be managed in such a way
that the supply of money in the country may be controlled.
The government should avoid paying back any of its previous loans during inflation so as to prevent an
increase in the circulation of money. Moreover, if the government manages to get a surplus budget, it
should be used to cancel public debt held by the central bank. The result will be anti-inflationary since
money taken from the public and commercial banks is being cancelled out and is removed from
circulation. But the problem is how to get a budget surplus, which is extremely difficult.
3. Price Control and Rationing
This is the most important and effective method available during war and other critical times
particularly because both monetary and fiscal policies are more or less useless during this period. Price
control implies the establishment to legal upper limits beyond which prices of particular goods should
not rise. The purpose of rationing, on the other hand, is to distribute the goods in short supply in an
equitable manner among all people, irrespective of their wealth and social status. Price control and
rationing generally go together. The chief objection behind use of this method to fight inflation is that
they restrict the freedom of the consumers and thus limit their welfare. Besides, its success depends on
administrative efficiency, which in many underdeveloped countries is very low.
4. Other Methods
Another important anti-inflationary device is to increase the supply of goods through either increased
production or imports. Production may be increased by shifting factors of production from the
production of less inflation sensitive goods, which are in comparative abundance to the production of
those goods which are in short supply and which are inflation-sensitive. Moreover, shortage of goods
internally may be relieved through imports of inflation sensitive goods, either on credit or in exchange
for export of luxury goods and other non-essentials.
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5. Realistic Methods
1. Increase the supply of goods and services: When the supply of goods and services is increased, the
prices will come down.
2. Population planning: Control on population by adopting different measures of family planning will
reduce the demand and finally prices will be controlled.
3. Price control policy: The govt. should adopt strict price control policy against the profiteers and
hoarders.
4. Economic Planning: Effective economic planning is necessary to control the inflation in the country.
Globalization
The tendency of investment funds and businesses to move beyond domestic and national markets to
other markets around the globe, thereby increasing the interconnectedness of different markets.
Globalization has had the effect of markedly increasing not only international trade, but also cultural
exchange.
Advantages of Globalization
Employment
Considered as one of the most crucial advantages, globalization has led to the generation of numerous
employment opportunities. Companies are moving towards the developing countries to acquire labor
force. This obviously caters to employment and income generation to the people in the host country.
Also, the migration of people, which has become easier has led to better jobs opportunities.
Education
A very critical advantage that has aided the population is the spread of education. With numerous
educational institutions around the globe, one can move out from the home country for better
opportunities elsewhere. Thus, integrating with different cultures, meeting and learning from various
people through the medium of education is all due to globalization. Developing countries or laborintensive countries have benefited the most.
Product Quality
The onset of international trade has given rise to intense competition in the markets. No longer does
one find limited number of commodities available. A particular commodity may fetch hundreds of
options with different prices. The product quality has been enhanced so as to retain the customers.
Today the customers may compromise with the price range but not with the quality of the product. Low
or poor quality can adversely affect consumer satisfaction.
Cheaper Prices
Globalization has brought in fierce competition in the markets. Since there are varied products to select
from, the producer can sustain only when the product is competitively priced. There is every possibility
that a customer may switch over to another producer if the product is priced exorbitantly. 'Customer is
the King', and hence can dictate the terms to a very large extent. Therefore, affordable pricing has
benefited the consumer in a great way.
Free Movement of Capital
Capital, the backbone of every economy, is of prime importance for the proper functioning of the
economy. Today, transferring money through banks is possible just by the click of a button, all due to
the electronic transfer that has made life very comfortable. Many huge firms are investing in the
developing countries by setting up industrial units outside their home country. This leads to Foreign
Direct Investment, which helps in promoting economic growth in the host country.
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Communication
Information technology has played a vital role in bringing the countries closer in terms of
communication. Every single information is easily accessible from almost every corner of the world.
Circulation of information is no longer a tedious task, and can happen in seconds. The Internet has
significantly affected the global economy, thereby providing direct access to information and products.
Transportation
Considered as the wheel of every business organization, connectivity to various parts of the world is no
more a serious problem. Today with various modes of transportation available, one can conveniently
deliver the products to a customer located at any part of the world. Besides, other infrastructural
facilities like, distribution, supply chain, and logistics have become extremely efficient and fast.
International Trade
Purchase and sale of commodities are not the only two transactions involved in international trade.
Today, international trade has broadened its horizon with the help of business process outsourcing.
Sometimes in order to concentrate on a particular segment of business it is a practice to outsource
certain services. Some countries practice free trade with minimal restrictions on EXIM (export-import)
policies. This has proved beneficial to businesses.
GDP Increase
Gross Domestic Product, commonly known as GDP, is the money value of the final goods and services
produced within the domestic territory of the country during an accounting year. As the market has
widened, the scope and demand for a product has increased. Producers familiarize their products and
services according to the requirements of various economies thereby tapping the untapped markets.
Thus, the final outcome in terms of financial gain enhances the GDP of the country. If statistics are of
any indication, the GDP of the developing countries has increased twice as much as before.
Disdvantages of Globalization
Health Issues
Globalization has given rise to more health risks and presents new threats and challenges for
epidemics. A very customary example is the dawn of HIV/AIDS. Having its origin in the wilderness of
Africa, the virus has spread like wildfire throughout the globe in no time. Food items are also
transported to various countries, and this is a matter of concern, especially in case of perishable items.
The safety regulations and the standards of food preparation are different in different countries, which
may pose a great risk to potential health hazards.
Loss of Culture
Conventionally, people of a particular country follow its culture and traditions from time immemorial.
With large number of people moving into and out of a country, the culture takes a backseat. People may
adapt to the culture of the resident country. They tend to follow the foreign culture more, forgetting
their own roots. This can give rise to cultural conflicts.
Uneven Wealth Distribution
It is said that the rich are getting richer while the poor are getting poorer. In the real sense,
globalization has not been able to reduce poverty. Instead it has led to the accumulation of wealth and
power in the hands of a few developed economies. Therefore the gap between the elite and the
underprivileged seems to be a never ending road, eventually leading to inequality.
Environment Degradation
The industrial revolution has changed the outlook of the economy. Industries are using natural
resources by means of mining, drilling, etc. which puts a burden on the environment. Natural resources
are depleting and are on the verge of becoming extinct. Deforestation is practiced owing to the non45, Anurag Nagar, Behind Press Complex, Indore (M.P.) Ph.: 4262100, www.rccmindore.com
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availability of land, thereby drastically reducing the forest cover. This in turn creates an imbalance in
the environment leading to climate change and occurrence of natural calamities.
Disparity
Though globalization has opened new avenues like wider markets and employment, there still exists a
disparity in the development of the economies. Structural unemployment owes to the disparity created.
Developed countries are moving their factories to foreign countries where labor is cheaply available.
The host country generates less revenues, and a major share of the profits fall into the hands of the
foreign company. They make humongous profits thereby creating a huge income gap between the
developed and the developing countries.
Cut-throat Competition
Opening the doors of international trade has given birth to intense competition. This has affected the
local markets dramatically. In recent times the standard of living has improved. People are therefore
ready to shell out extra money for a product that may be available at a lower price. This is because of
the modern marketing techniques like advertising and branding. The local players thereby suffer huge
losses as they lack the potential to advertise or export their products on a large scale. Therefore the
domestic markets shrink.
Conflicts
Every economy wants to be at the top spot and be the leader. The fast-paced economies, that is the
developed countries are vying to be the supreme power. It has given rise to terrorism and other forms
of violence. Such acts not only cause loss of human life but also huge economic losses.
Monopoly
Monopoly is a situation wherein only one seller has a say in a particular product or products. It is
possible that when a product is the leader in its field, the company may begin to exploit the consumers.
As there exists no close competitors, the leader takes full advantage of the sale of its product, which
may later lead to illegal and unethical practices being followed. Monopoly is disastrous as it widens the
gap between the developed and developing countries.
WHAT IS LIBERALIZATION /FREE TRADE
Free trade occurs when there are no artificial barriers put in place by governments to restrict the flow
of goods and services between trading nations.When trade barriers, such as tariffs and subsidies are
put in place, they protect domestic producers from international competition and hinder free trade
flows.
ADVANTAGES OF FREE TRADE
1) Increased production: Free trade enables countries to specialize in the production of those
commodities in which they have a comparative advantage With specialization countries are able
to take advantage of efficiencies generated from economies of scale and increased output.
International trade increases the size of a firms market, resulting in lower average costs and
increased productivity, ultimately leading to increased production.
2) Production efficiencies: Free trade improves the efficiency of resource allocation. The more
efficient use of resources leads to higher productivity and increasing total domestic output of
goods and services.
3) Increased competition: Increased competition promotes innovative production methods, the use
of new technology, marketing and distribution methods.
4) Benefits to consumers: Consumers benefit in the domestic economy as they can now obtain a
greater variety of goods and services. The increased competition ensures goods and services, as
well as inputs, are supplied at the lowest prices.
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5)
6)
7)
Foreign exchange gains: When a domestic country sells/exports overseas it receives hard
currency from the countries that buy the goods. This money is then used to pay for imports that
are produced more cheaply overseas.
Employment: As resources move to more productive areas of the economy. Employment will
increase in exporting industries and workers will be displaced as import competing industries fold
(close down) in the competitive environment.
Economic growth: The countries involved in free trade experience rising living standards,
increased real incomes and higher rates of economic growth. This is created by more competitive
industries, increased productivity, efficiency and production levels.
2)
3)
4)
5)
6)
With the removal of trade barriers, structural unemployment may occur in the short
term. This can impact upon large numbers of workers, their families and local economies. Often it
can be difficult for these workers to find employment in growth industries and government
assistance is necessary.
Increased domestic economic instability from international trade cycles, as economies
become dependent on global markets. This means that businesses, employees and consumers
are more vulnerable to downturns in the economies of our trading partners, eg. Recession in the
USA leads to decreased demand for Indian exports, leading to falling export incomes, lower GDP,
lower incomes, lower domestic demand and rising unemployment.
International markets are not a level playing field as countries with surplus products may
dump them on world markets at below cost. Some efficient industries may find it difficult to
compete for long periods under such conditions. Further, countries whose economies are largely
agricultural face unfavorable terms of trade (ratio of export prices to import prices) whereby their
export income is much smaller than the import payments they make for high value added imports,
leading to large foreign debt levels.
Developing or new industries may find it difficult to become established in a competitive
environment with no short-term protection policies by governments, according to the infant
industries argument. It is difficult to develop economies of scale in the face of competition from
large foreign MNCs. This can be applied to infant industries or infant economies (developing
economies).
Free trade can lead to pollution and other environmental problems as companies fail to
include these costs in the price of goods in trying to compete with companies operating under
weaker environmental legislation in some countries.
Pressure to increase protection during the GFC During the global financial crisis and recession
of 2008-2009, the impact of falling employment meant that protection pressures started to rise in
many countries. Domestic producers demand tariffs and protectionism from the government.
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UNIT-V
FUNCTIONS OF COMMERCIAL BANK
Definitions of Commercial Bank:
1. Crowther, A commercial bank collects money from those who have it to spare or who are
saving it out of their income and lends this money to those who require it.
2. Reed and gill, a commercial bank is a financial institution that accepts demand deposits and
makes commercial loans and is regulated by a bank regulatory agency.:
3. The Indian banking companies act, 1949 (now termed as the banking regulation act, since
1956) lays down that the commercial banking consists in The accepting for the purpose of
lending or investment, deposits of money from the public, repayable on demand or otherwise
and withdraw able by cheque, draft, order or other.
Thus, a commercial bank is an institution which accepts deposits from the public in turn advance loans
by creating credit.
Features:
1. It is a commercial institution; it aims at earning profit.
2. It deals with money; it accepts deposits and advances loans.
3. It deals with credit; it has ability to create credit.
It is clear that commercial banks act as a bridge between the users of capital (investors) and those
who save (savers). They activate the idle resources of the community and use them for productive
purposes.
Commercial Banks and other Financial Institutions: Commercial Banks are different from other
financial institutions (F.I.) from the following point of view:
1. Acceptance of chequable deposits is a necessary, but not sufficient condition for financial
institutions (F.I.) to be a bank. For example, post office savings banks are not banks in this sense
of the term even though they accept deposits from the public. This is because, they do not
perform the other essential function of lending.
2. Leading alone does not make Financial Institution (F.I.) a bank. For example, many FIs like LIC,
UTI, and IDBI, etc. lend to others but they are not banks in this sense of the term, is they don not
accept chequable deposits.
3. Financial Institutions cannot create credit though they may he accepting deposits and making
advances.
CLASSIFICATION OF COMMERCIAL BANKS
Commercial banks can be of two types:
I. Scheduled commercial bank and II. Non-scheduled commercial bank.
There are three kinds of the scheduled commercial bank.
(a) Public sector banks.
(b) Private sector banks.
(c) Foreign banks.
Public sector banks can be of two types:
(a) SBI and its subsidiaries.
(b) Other nationalized banks.
Chart 1. gives the classification of commercial banks.
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certain types of securities. Since 1956, selective controls of credit are increasingly being used by the
Reserve Bank.
The Reserve Bank of India is armed with many more powers to control the Indian money market. Every
bank has to get a licence from the Reserve Bank of India to do banking business within India, the licence
can be cancelled by the Reserve Bank of certain stipulated conditions are not fulfilled. Every bank will
have to get the permission of the Reserve Bank before it can open a new branch. Each scheduled bank
must send a weekly return to the Reserve Bank showing, in detail, its assets and liabilities. This power
of the Bank to call for information is also intended to give it effective control of the credit system. The
Reserve Bank has also the power to inspect the accounts of any commercial bank.
As supreme banking authority in the country, the Reserve Bank of India, therefore, has the following
powers:
(a) It holds the cash reserves of all the scheduled banks.
(b) It controls the credit operations of banks through quantitative and qualitative controls.
(c) It controls the banking system through the system of licensing, inspection and calling for
information.
(d) It acts as the lender of the last resort by providing rediscount facilities to scheduled banks.
5. Custodian of Foreign Reserves
The Reserve Bank of India has the responsibility to maintain the official rate of exchange. According to
the Reserve Bank of India Act of 1934, the Bank was required to buy and sell at fixed rates any amount
of sterling in lots of not less than Rs. 10,000. The rate of exchange fixed was Re. 1 = sh. 6d. Since 1935
the Bank was able to maintain the exchange rate fixed at lsh.6d. though there were periods of extreme
pressure in favour of or against the rupee. After India became a member of the International Monetary
Fund in 1946, the Reserve Bank has the responsibility of maintaining fixed exchange rates with all
other member countries of the I.M.F.
Besides maintaining the rate of exchange of the rupee, the Reserve Bank has to act as the custodian of
India's reserve of international currencies. The vast sterling balances were acquired and managed by
the Bank. Further, the RBI has the responsibility of administering the exchange controls of the country.
6. Supervisory functions
In addition to its traditional central banking functions, the Reserve bank has certain non-monetary
functions of the nature of supervision of banks and promotion of sound banking in India. The Reserve
Bank Act, 1934, and the Banking Regulation Act, 1949 have given the RBI wide powers of supervision
and control over commercial and co-operative banks, relating to licensing and establishments, branch
expansion, liquidity of their assets, management and methods of working, amalgamation,
reconstruction, and liquidation. The RBI is authorised to carry out periodical inspections of the banks
and to call for returns and necessary information from them. The nationalisation of 14 major Indian
scheduled banks in July 1969 has imposed new responsibilities on the RBI for directing the growth of
banking and credit policies towards more rapid development of the economy and realisation of certain
desired social objectives. The supervisory functions of the RBI have helped a great deal in improving
the standard of banking in India to develop on sound lines and to improve the methods of their
operation.
7. Promotional functions
With economic growth assuming a new urgency since Independence, the range of the Reserve Bank's
functions has steadily widened. The Bank now performs a varietyof developmental and promotional
functions, which, at one time, were regarded as outside the normal scope of central banking. The
Reserve Bank was asked to promote banking habit, extend banking facilities to rural and semi-urban
areas, and establish and promote new specialised financing agencies. Accordingly, the Reserve Bank
has helped in the setting up of the IFCI and the SFC; it set up the Deposit Insurance Corporation in 1962,
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the Unit Trust of India in 1964, the Industrial Development Bank of India also in 1964, the Agricultural
Refinance Corporation of India in 1963 and the Industrial Reconstruction Corporation of India in 1972.
These institutions were set up directly or indirectly by the Reserve Bank to promote saving habit and to
mobilise savings, and to provide industrial finance as well as agricultural finance. As far back as 1935,
the Reserve Bank of India set up the Agricultural Credit Department to provide agricultural credit. But
only since 1951 the Bank's role in this field has become extremely important. The Bank has developed
the co-operative credit movement to encourage saving, to eliminate moneylenders from the villages
and to route its short term credit to agriculture. The RBI has set up the Agricultural Refinance and
Development Corporation to provide long-term finance to farmers.
METHODS OF CREDIT CONTROL- QUALITATIVE & QUANTITATIVE METHODS
The RBI adopt two methods to control credit in modern times for regulating bank advances. They are as
follows:(A) Quantitative or General Credit Control
This method aims to regulate the amount of bank advance. This method includes:
(a) Bank Rate
(b) Open Market Operation
(c) Variables Reserves Ratio
(a) Bank Rate: It is the rate at which central bank discounts the securities of commercial banks or
advance loans to commercial banks. This rate is the minimum and it affects both cost and availability of
credit. Bank rate is different from market rate. Market rate is the rate of discount prevailing in the
money market among other lending institutions. Generally bank rate is higher than the market rate. If
the bank rate is changed all the other rates normally change at the same direction. A central bank
control credit by manipulating the bank rate. If the central bank raise the bank rate to control credit,
the market discount rate and other lending rates in the money will go up. The cost of credit goes up and
demand for credit goes down. As a result, the volume of bank loans and advances is curtailed. Thus
raise in bank rate will contract credit.
(b) Open Market Operation: It refers to buying and selling of Government securities by the central
bank in the open market. this method of credit control become very popular after the 1st World War.
During inflation, the bank will securities and during depression, it will purchase securities from the
public and financial institutions. The RBI is empowered to buy and sell government securities from the
public and financial institutions. The RBI is empowered to buy and sell government securities, treasury
bills and other approved securities. The central bank uses the weapon to overcome seasonal stringency
in funds during the slack season. When the central bank sells securities, they are purchased by the
commercial banks and private individuals. So money supply is reduced in the economy and there is
contraction in credit.
When the securities are purchased by the central bank, money goes to the commercial banks and the
customers. SO money supply is increased in the economy and there is more demand for credit.
Thus open market operation is one of the superior instrument of credit control. But for achieving an
ideal result both Bank Rate and Open Market Operation must be used simultaneously.
(c) Variable Reserve Ratio (VRR): This is a new method of credit control adopted by central bank.
Commercial banks keep cash reserves with the central bank to maintain for the purpose of liquidity and
also to provide the means for credit control. The cash reserve is also called minimum legal reserve
requirement. The percentage of this ratio can be changed legally by the central bank. The credit
creation of commercial banks depends on the value of cash reserves. If the value of reserve ratio
increase and other things remain constant, the power of credit creation by the commercial bank is
decreased and vice versa. Thus by varying the reserve ratio, the lending capacity of commercial banks
can be affected.
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fact that the company is liable to pay a specified amount with interest and although the money raised
by the debentures becomes a part of the company's capital structure, it does not become share capital.
Senior debentures get paid before subordinate debentures, and there are varying rates of risk and
payoff for these categories. Debentures are generally freely transferable by the debenture holder.
Debenture holders have no rights to vote in the company's general meetings of shareholders, but they
may have separate meetings or votes e.g. on changes to the rights attached to the debentures. The
interes`t paid to them is a charge against profit in the company's financial statements
DIFFERENCE BETWEEN SHARES & DEBENTURES
The major differences between debentures and shares (1) Rights the Debentures constitute loan and
only a creditor of the company. The shares represents a part of the share capital of the capital. (2)
Approval in debentures question of getting approval for payment of interest does not arise. In shares,
Dividend is payable only when it is recommended by the Board and approved by the general meeting of
the shareholders. (3) Liability in the debentures is not having such liability. In share sholders liability is
limited to the unpaid amount of the shares. (4) Return of Capital in debentures are redeemable either at
a fixed date or at the option of the company during the lifetime itself. In shares are non-repayable
during the lifetime of the company except in the case of redeemable preference shares. (5) Charge on
Assets in the Debentures are generally secured and shares have no charge on the assets of the
company.
CONCEPT OF SEBI
Securities Exchange Board of India (SEBI) was set up in 1988 to regulate the functions of securities
market. SEBI promotes orderly and healthy development in the stock market but initially SEBI was not
able to exercise complete control over the stock market transactions. It was left as a watch dog to
observe the activities but was found ineffective in regulating and controlling them. As a result in May
1992, SEBI was granted legal status. SEBI is a body corporate having a separate legal existence and
perpetual succession.
Reasons for Establishment of SEBI:
With the growth in the dealings of stock markets, lot of malpractices also started in stock markets such
as price rigging, unofficial premium on new issue, and delay in delivery of shares, violation of rules and
regulations of stock exchange and listing requirements. Due to these malpractices the customers
started losing confidence and faith in the stock exchange. So government of India decided to set up an
agency or regulatory body known as Securities Exchange Board of India (SEBI).
Purpose and Role of SEBI:
SEBI was set up with the main purpose of keeping a check on malpractices and protect the interest of
investors. It was set up to meet the needs of three groups.
1. Issuers:
For issuers it provides a market place in which they can raise finance fairly and easily.
2. Investors:
For investors it provides protection and supply of accurate and correct information.
3. Intermediaries:
For intermediaries it provides a competitive professional market.
Objectives of SEBI:
The overall objectives of SEBI are to protect the interest of investors and to promote the development
of stock exchange and to regulate the activities of stock market. The objectives of SEBI are:
1. To regulate the activities of stock exchange.
2. To protect the rights of investors and ensuring safety to their investment.
3. To prevent fraudulent and malpractices by having balance between self regulation of business and its
statutory regulations.
4. To regulate and develop a code of conduct for intermediaries such as brokers, underwriters, etc.
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Functions of SEBI:
The SEBI performs functions to meet its objectives.
1. Protective Functions:
These functions are performed by SEBI to protect the interest of investor and provide safety of
investment.
As protective functions SEBI performs following functions:
(i) It Checks Price Rigging:
Price rigging refers to manipulating the prices of securities with the main objective of inflating or
depressing the market price of securities. SEBI prohibits such practice because this can defraud and
cheat the investors.
(ii) It Prohibits Insider trading:
Insider is any person connected with the company such as directors, promoters etc. These insiders
have sensitive information which affects the prices of the securities. This information is not available to
people at large but the insiders get this privileged information by working inside the company and if
they use this information to make profit, then it is known as insider trading, e.g., the directors of a
company may know that company will issue Bonus shares to its shareholders at the end of year and
they purchase shares from market to make profit with bonus issue. This is known as insider trading.
SEBI keeps a strict check when insiders are buying securities of the company and takes strict action on
insider trading.
(iii) SEBI prohibits fraudulent and Unfair Trade Practices:
SEBI does not allow the companies to make misleading statements which are likely to induce the sale or
purchase of securities by any other person.
(iv) SEBI undertakes steps to educate investors so that they are able to evaluate the securities of
various companies and select the most profitable securities.
(v) SEBI promotes fair practices and code of conduct in security market by taking following steps:
(a) SEBI has issued guidelines to protect the interest of debenture-holders wherein companies cannot
change terms in midterm.
(b) SEBI is empowered to investigate cases of insider trading and has provisions for stiff fine and
imprisonment.
(c) SEBI has stopped the practice of making preferential allotment of shares unrelated to market prices.
2. Developmental Functions:
These functions are performed by the SEBI to promote and develop activities in stock exchange and
increase the business in stock exchange. Under developmental categories following functions are
performed by SEBI:
(i) SEBI promotes training of intermediaries of the securities market.
(ii) SEBI tries to promote activities of stock exchange by adopting flexible and adoptable approach in
following way:
(a) SEBI has permitted internet trading through registered stock brokers.
(b) SEBI has made underwriting optional to reduce the cost of issue.
(c) Even initial public offer of primary market is permitted through stock exchange.
3. Regulatory Functions:
These functions are performed by SEBI to regulate the business in stock exchange. To regulate the
activities of stock exchange following functions are performed:
(i) SEBI has framed rules and regulations and a code of conduct to regulate the intermediaries such as
merchant bankers, brokers, underwriters, etc.
(ii) These intermediaries have been brought under the regulatory purview and private placement has
been made more restrictive.
(iii) SEBI registers and regulates the working of stock brokers, sub-brokers, share transfer agents,
trustees, merchant bankers and all those who are associated with stock exchange in any manner.
(iv) SEBI registers and regulates the working of mutual funds etc.
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also varies from that of the face value. The resale value of the securities in the secondary market is
dependant on the fluctuating interest rates.
Securities issued by a company for the first time are offered to the public in the primary market.
Once the IPO is done and the stock is listed, they are traded in the secondary market. The main
difference between the two is that in the primary market, an investor gets securities directly from
the company through IPOs, while in the secondary market, one purchases securities from other
investors willing to sell the same.
Equity shares, bonds, preference shares, treasury bills, debentures, etc. are some of the key
products available in a secondary market. SEBI is the regulator of the same.
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3) Principle of Indemnity
4) Principle of Contribution
5) Principle of Subrogation
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LIFE INSURANCE : Life insurance (or commonly life assurance, especially in the Commonwealth) is a
contract between an insured (insurance policy holder) and an insurer or assurer, where the insurer
promises to pay a designated beneficiary a sum of money (the "benefits") in exchange for a premium,
upon the death of the insured person. Depending on the contract, other events such as terminal illness
or critical illness may also trigger payment. The policy holder typically pays a premium, either regularly
or as a lump sum. Other expenses (such as funeral expenses) are also sometimes included in the
benefits.
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Life policies are legal contracts and the terms of the contract describe the limitations of the insured
events. Specific exclusions are often written into the contract to limit the liability of the insurer;
common examples are claims relating to suicide, fraud, war, riot, and civil commotion.
Life-based contracts tend to fall into two major categories:
Protection policies designed to provide a benefit in the event of specified event, typically a
lump sum payment. A common form of this design is term insurance.
Investment policies where the main objective is to facilitate the growth of capital by regular or
single premiums. Common forms (in the US) are whole life, universal life, and variable life
policies.
GENERAL INSURANCE :General insurance or non-life insurance policies, including automobile and
homeowners policies, provide payments depending on the loss from a particular financial event.
General insurance typically comprises any insurance that is not determined to be life insurance. It is
called property and casualty insurance in the U.S. and Canada and Non-Life Insurance in Continental
Europe.
DIFFERENCE BETWEEN LIFE INSURANCE & GENERAL INSURANCE
Type of contract
o Life insurance is a non-personal insurance contract. This means that the policyholder and the
person being insured do not have to be the same person. General insurance is always a personal
contract where the insurance company contracts with you directly for insurance protection.
Function
o Both life insurance and general insurance accept premiums in exchange for insurance benefits.
Insurance premiums are invested into bonds or bond-like investments that produce stable and
consistent returns for the insurance company. The investments, plus premium payments, also
ensure that the insurance company can pay the promised benefits that are outlined in the
insurance policy. When you need to file a claim, both types of insurance require a claim form for
you to fill out. The payment of benefits, and the amount of the benefit that is payable, are always
spelled out in your insurance contract.
Significance
o Life insurance insures your life or the life of someone that you have an economic interest in, like
your spouse, children, siblings or business partners. When the insured individual dies, the life
insurance policy pays a death benefit that is fixed. This is called a valued contract. A valued
contract pays a fixed sum of money, regardless of the nature of the loss insured by the contract.
General insurance insures homes, automobiles and other personal property. This type of
insurance is sometimes referred to as "property and casualty" insurance. General insurance is
indemnity insurance. Indemnity insurance pays just enough money to you to repair or replaced
the insured property. For example, your homeowner's insurance may cover your entire home
and the contents of it. However, if your roof is damaged in a storm, the policy only pays enough
to repair the damage.
Benefits
o The benefit of life insurance is that it pays off any financial obligations you have left after you
die. It can pay more than that, however, because life insurance pays a fixed amount. Death
benefits can be used to create wealth for the surviving beneficiaries, or they can be used to
replace the primary income earner's salary for a surviving spouse.
General insurance is beneficial in that the insurance ensures that, almost regardless of the damage
done, that the property will be repaired or replaced. While general insurance generally has a maximum
payout determined by the value of your property, it does not pay a fixed amount, so you won't have to
guess at how much insurance you need to purchase.
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